Hanover de Broke

The effects of ignoring the issue and failing to appreciate the value of protecting your family

The latest Aviva Family Finances Report reveals that many UK families are putting luxuries ahead of protecting their loved ones financially.

The report discovered that while 50 per cent of families are happy to pay for a satellite television package, just 40 per cent have life insurance. It also found that families are more likely to have insurance for their mobile phone (14 per cent) than insurance that will protect their family financially if they were to suffer a critical illness (13 per cent).

Similarly, more people have taken out an extended warranty on electrical items (13 per cent) than have income protection insurance, which would potentially pay an income for life should they be unable to work as a result of an accident or illness (10 per cent).

Lack of understanding
The report also reveals that the majority of UK families are avoiding the issue of what they would do if something happened to an income earner because they find discussing their finances and mortality ‘uncomfortable’. This is in spite of the financial worries that could be caused by not having protection, exacerbating emotional distress at a difficult time. As a result, many families ignore the issue and fail to appreciate the value of protecting their family compared to spending on other items.

Avoiding putting measures in place
No one likes to dwell on poor health or mortality, but by denying that illness – or worse – is even a possibility, people are avoiding putting measures in place to protect their loved ones. Too many people assume that someone else will step in and look after their families if they weren’t there to provide for them, but the reality is very different.

UNNECESSARY RISK
People need to ask themselves just how they would pay for their mortgages, their food and all the other costs of living should they suddenly lose an income. While no one likes to think about ‘what ifs’, by not even considering these scenarios, people could be putting the future financial security of their families at unnecessary risk.

Source – The Aviva Family Finances Report is an in-depth study into the financial needs of the 84 per cent of the UK population who live as part of a modern family.

Data was sourced from the Aviva Family Index, which used findings from over 10,000 people who are members of one of the six groups of families identified above via Opinion Matters. This report is a definitive appraisal of the personal finances of families in the UK. Not only does it look at personal wealth, income sources and expenditure patterns, but also tracks how these change across the different types of family unit.

Compounding of returns for the long term

If you are an income seeker, frozen interest rates at historic lows mean real losses for many savers in bank and building society deposits which fail to match inflation.

The most popular forms of income investment are bonds (which are also known as ‘fixed interest’ investments) and cash, both of which pay a regular, consistent rate of interest either annually, twice a year or four times a year. You can also obtain an income from shares in the form of dividends, and many equity funds are set up solely with the aim of generating a stable income. Importantly equity income funds often aim to achieve not only stability, but an increasing income in the long term.

Income stocks are most usually found in solid industries with established companies that generate good cash flow. They have little need to reinvest their profits to help grow the business or fund research and development of new products and are therefore able to pay sizeable dividends back to their investors. Examples of traditional income-generating companies would include utilities such as oil and gas, telephone companies, banks and insurance companies.
You should remember that these investments do not include the same security of capital which is afforded with a deposit account.

10 income investing tips

1. Sustainable long-term dividend growth – Investing in businesses when the growth potential is not reflected in the valuation of their shares not only reduces the risk of losing money, it increases the upside opportunity.
2. Inflation matters - Always bear in mind the detrimental effect of inflation. Corporate and Government bonds offer higher yields than cash but returns can be eroded by inflation. Investment in property or equities provides a vehicle to help achieve an income that rises to keep pace with inflation.
3. Consider international diversification – A small number of UK companies account for some 40 per cent of UK dividend payouts. This compares with over 100 companies in the US, for example, that provide the opportunity to increase the longevity of dividend growth.
4. Patience is a virtue - Investing for income is all about the compounding of returns for the long term. As a general rule, those businesses best placed to offer this demonstrate consistent returns on invested capital and visible earnings streams.
5. Reliability is the key – Select sectors of the equity market that do not depend on strong economic growth to deliver attractive returns to investors.
6. High and growing free cash flow – Look for companies with money left over after all capital expenditure, as this is the stream out of which rising dividends are paid. The larger the free cash flow relative to the dividend payout the better.
7. Dividend growth – In the short term, share prices are buffeted by all sorts of influences, but over longer time periods fundamentals have the opportunity to shine through. Dividend growth is the key determinant of long-term share price movements – the rest is sentiment.
8. Cautious approach - Profits and dividends of utility companies are at the whim of the regulator. Be cautious of companies that pay a high dividend because they have gone ex-growth – such a position is not usually sustainable indefinitely.
9. Investment diversification – The first rule of investment is often said to be ‘spread risk’. Diminishing risk is particularly important for income-seekers who cannot afford to lose capital.
10. Tax-efficiency - Increase your net income by using an ISA (Individual Savings Account). ISA income is free of taxation, thereby potentially improving the amount of income you actually receive. ISAs are also free from capital gains tax, allowing you to switch funds or cash in without a tax charge.

Interest rates have fallen to their lowest levels in the Bank of England’s 315-year history and could fall even further, along with further inflationary falls.

If, during this current recessionary climate, you are seeking higher returns from your investments, you may want to consider a combination of the following: corporate bonds, equity income, absolute return funds and emerging markets. This will, of course, depend a great deal on your attitude towards risk for return.

In times of economic uncertainty it is even more important to spread risk by having a good mix of assets. You need to get the right balance within your portfolio and this will also depend upon your individual needs.

Corporate bonds are issued by companies to raise capital. The bond is a tradeable instrument in its own right and its value will tend to rise as interest rates fall and remain low. Conversely there value tends to fall when interest rates rise.

Absolute return funds can protect investors when markets go down and, indeed, in some cases give a return. When markets rise, they should also capture a portion of the rise. They achieve their steadier results through a combination of different strategies.
Some exposure to emerging economies, whose currencies look likely to appreciate against sterling, is worth considering. There is also an argument for foreign income funds, even if their dividends remain the same.

 Planning for the future is not to be taken lightly

We all want to protect our wealth and help ensure our families are provided for when we die. However, increasingly HM Revenue & Customs (HMRC) are challenging the valuations of properties given for Inheritance Tax (IHT) purposes, according to accountants UHY Hacker Young.

IHT is currently payable at 40 per cent on any amount over £325,000 – the nil rate band (tax year 2011/12). The nil rate band is the term used to describe the value an estate can have before it is taxed (£650,000 for married couples). So if you have an estate worth £500,000, £175,000 is taxed at 40 per cent, meaning the IHT bill would be £70,000.

The taxman raised £70m in additional tax last year – an average of £24,600 extra tax per case – and are targeting beneficiaries who claim a property they’ve inherited is worth less than it is in order to pay less tax.

During the financial year 2010/11, 16,000 estates paid IHT. Of these, more than a fifth – 3,441 – had the valuation of the property increased, while just 800 had valuations reduced, according to HMRC figures.

Reducing an Inheritance Tax bill

Write a Will
Making a Will is the first step to reducing your IHT bill. It helps you get an idea of what your estate is worth, therefore providing a good basis to understand how much IHT planning is required.

Great give-away
You can give away cash or assets up to the value of £3,000 a year without it incurring any taxes. This can also be backdated by one year if not already used, for example, a couple could effectively gift £12,000 in the first year if not already used and then £6,000 (£3,000 each) thereafter. Parents can also give up to £5,000 to each of their children as a wedding/civil partnership gift while grandparents can give up to £2,500. Others can also contribute to loved ones’ weddings/civil partnerships but are only allowed to give up to £1,000.
You can make small gifts up to £250 to as many people as you like, as long as you haven’t already gifted that person in the same tax year.

If you are still working and earning an income, you are also permitted to give away any surplus amounts of your income provided that, in making these gifts, your own standard of living is not affected. You must not then access your capital (savings and investments) to live off.

Seven-year rule
The seven-year rule allows you to make additional tax-free gifts providing you do not pass away within the next seven years. These gifts are called ‘potentially exempt transfers’ (PETs) and can be anything from cash to property. However, you cannot give something away and still benefit from it, for example, you can’t give away the family home and then continue to live in it unless you pay the market rent.

If you were to pass away before the seven years were up, the assets would be taxable. However, the amount would vary and depend on how close to the seven-year milestone you were. For example, if you were to die within six years, the tax bill would be less than if you passed away within a couple of months. This is known as ‘taper relief’.

A matter of trust
Placing assets into a trust in your lifetime could be a good way to decrease your IHT bill. Limited to the nil rate band, these gifts count as potentially exempt transfers. This means the same rules apply, so if you pass away before the seven years are up, IHT will be due.

It is possible for a Settlor to place assets in excess of the nil rate band in a trust. These gifts are called ‘chargeable transfers’ as tax is payable immediately the asset goes into the trust. However, if the Settlor dies within seven years then there could be an IHT liability to pay too.

Rural ambitions
Buying farmland is an alternative way to help reduce a potential IHT bill, as farmland qualifies for agricultural property relief of up to 100 per cent after two years of ownership. The land has to be actively worked on for ‘agricultural purposes’ so, unless you have rural ambitions, this will not be an option for the majority.

Levels and bases of and reliefs from taxation are subject to change and their value depends on the individual circumstances of the investor.

Tax saving incentives for substantial charitable legacies

If you have an estate currently worth more than £325,000, you should plan early and act decisively if you are to avoid burdening your heirs with a future Inheritance Tax (IHT) liability.

During Budget 2011 measures were announced to encourage charitable giving that will be of interest to both the voluntary sector and those who donate to charity. The reduction from 40 per cent to 36 per cent in the rate of IHT will become applicable from 6 April 2012 where 10 per cent or more of a deceased’s net estate is left to charity.

The current £325,000 nil rate IHT band is frozen until April 2015 and will be indexed against the Consumer Prices Index measure of inflation.

The move to boost philanthropy, known as ‘10 for 10’, will cost the Treasury about £170m a year by 2015/16 but it is estimated the measure could result in more than £350m worth of additional legacies in the first four years of the scheme.

The Chancellor, Mr Osborne told the Commons: ‘If you leave 10 per cent or more of your estate to charity, then the Government will take 10 per cent off your IHT rate. Let’s be clear: no beneficiaries will be better off, just the charities to the tune of £300m. I want to make giving 10 per cent of your legacy to charity the new norm in our country.’

People with estates larger than £325,000 should arrange their affairs carefully to avoid paying more IHT than they need to. It’s never too early to think about this subject. There is a plethora of things people can do to reduce a liability and ensure they leave the maximum amount to their family and not the taxman.

This is a very complicated area of financial planning and obtaining professional advice is essential to preserve your wealth for future generations. For information about how we could help you, please contact us to discuss your requirements.

Effective inheritance tax planning could save your beneficiaries thousands of pounds, maybe even hundreds of thousands depending on the size of your estate. At its simplest, inheritance tax (IHT) is the tax payable on your estate when you die if the value of your estate exceeds a certain amount.

IHT is currently paid on amounts above £325,000 (£650,000 for married couples and registered civil partnerships) for the current 2009/10 tax year, at a rate of 40 per cent. From 2010/11 this figure is set to increase to £350,000 (£700,000 for married couples and registered civil partnerships). If the value of your estate, including your home and certain gifts made in the previous seven years, exceeds the IHT threshold, tax will be due on the balance at 40 per cent.

Without proper tax planning, many people could end up leaving a substantial tax liability on their death, considerably reducing the value of the estate passing to their chosen beneficiaries.Your estate includes everything owned in your name, the share of anything owned jointly, gifts from which you keep back some benefit (such as a home given to a son or daughter but in which you still live) and assets held in some trusts from which you receive an income.

Against this total value is set everything that you owed, such as any outstanding mortgages or loans, unpaid bills and costs incurred during your lifetime for which bills have not been received, as well as funeral expenses.

Any amount of money given away outright to an individual is not counted for tax if the person making the gift survives for seven years. These gifts are called ‘potentially exempt transfers’ and are useful for tax planning.

Money put into a ‘bare’ trust (a trust where the beneficiary is entitled to the trust fund at age 18) counts as a potentially exempt transfer, so it is possible to put money into a trust to prevent grandchildren, for example, from having access to it until they are 18.

However, gifts to most other types of trust will be treated as chargeable lifetime transfers. Chargeable lifetime transfers up to the threshold are not subject to tax but amounts over this are taxed at 20 per cent with a further
20 per cent payable if the person making the gift dies within seven years.

Some cash gifts are exempt from tax regardless of the seven-year rule. Regular gifts from after-tax income, such as a monthly payment to a family member, are also exempt as long as you still have sufficient income to maintain your standard of living.

Any gifts between husbands and wives, or registered civil partners, are exempt from IHT whether they were made while both partners were still alive or left to the survivor on the death of the first. Tax will be due eventually when the surviving spouse or civil partner dies if the value of their estate is more than the combined tax threshold, currently £650,000. If gifts are made that affect the liability to IHT and the giver dies less than seven years later, a special relief known as ‘taper relief’ may be available. The relief reduces the amount of tax payable on a gift.

In most cases, IHT must be paid within six months from the end of the month in which the death occurs. If not, interest is charged on the unpaid amount. Tax on some assets, including land and buildings, can be deferred and paid in instalments over ten years.

However, if the asset is sold before all the instalments have been paid, the outstanding amount must be paid. The IHT threshold in force at the time of death is used to calculate how much tax should be paid.

If you have concerns about the impact IHT could have on your particular situation, please contact us so that we can review your financial position and offer professional advice about the options available.

You may decide to use a trust to pass assets to beneficiaries, particularly those who aren’t immediately able to look after their own affairs. If you do use a trust to give something away, this removes it from your estate provided you don’t use it or get any benefit from it. But bear in mind that gifts into trust may be liable to inheritance tax.

Trusts offer a means of holding and managing money or property for people who may not be ready or able to manage it for themselves. Used in conjunction with a will, they can also help ensure that your assets are passed on in accordance with your wishes after you die. Here we take a look at the main types of UK family trust.

When writing a will, there are several kinds of trust that can be used to help minimise an IHT liability. On March 22, 2006 the government changed some of the rules regarding trusts and introduced some transitional rules for trusts set up before this date.

A trust might be created in various circumstances, for example:

when someone is too young to handle their affairs

when someone can’t handle their affairs because they’re incapacitated

to pass on money or property while you’re still alive

under the terms of a will

when someone dies without leaving a will (England and Wales only)

What is a trust?
A trust is an obligation binding a person called a trustee to deal with property in a particular way for the benefit of one or more ‘beneficiaries’.
 
Settlor
The settlor creates the trust and puts property into it at the start, often adding more later. The settlor says in the trust deed how the trust’s property and income should be used.

Trustee
Trustees are the ‘legal owners’ of the trust property and must deal with it in the way set out in the trust deed. They also administer the trust. There can be one or more trustees. 

Beneficiary
This is anyone who benefits from the property held in the trust. The trust deed may name the beneficiaries individually or define a class of beneficiary, such as the settlor’s family.

Trust property
This is the property (or ‘capital’) that is put into the trust by the settlor. It can be anything, including:

land or buildings
investments
money
antiques or other valuable property

The main types of private UK trust

Bare trust
In a bare trust the property is held in the trustee’s name but the beneficiary can take actual possession of both the income and trust property whenever they want. The beneficiaries are named and cannot be changed.

You can gift assets to a child via a bare trust while you are alive, which will be treated as a Potentially Exempt Transfer (PET) until the child reaches age 18, (the age of majority in England and Wales), when the child can legally demand his or her share of the trust fund from the trustees.

All income arising within a bare trust in excess of £100 per annum will be treated as belonging to the parents (assuming that the gift was made by the parents). But providing the settlor survives seven years from the date of placing the assets in the trust, the assets can pass IHT free to a child at age 18.

Life interest or interest in possession trust
In an interest in possession trust the beneficiary has a legal right to all the trust’s income (after tax and expenses), but not to the property of the trust.

These trusts are typically used to leave income arising from a trust to a second surviving spouse for the rest of their life. On their death, the trust property reverts to other beneficiaries, (known as the remaindermen), who are often the children from the first marriage.

You can, for example, set up an interest in possession trust in your will. You might then leave the income from the trust property to your spouse for life and the trust property itself to your children when your spouse dies.

With a life interest trust, the trustees often have a ‘power of appointment’, which means they can appoint capital to the beneficiaries (who can be from within a widely defined class, such as the settlor’s extended family) when they see fit.

Where an interest in possession trust was in existence before March 22, 2006, the underlying capital is treated as belonging to the beneficiary or beneficiaries for IHT purposes, for example, it has to be included as part of their estate.

Transfers into interest in possession trusts after March 22, 2006 are taxable as follows:

20 per cent tax payable based on the amount gifted into the trust at the outset, which is in excess of the prevailing nil rate band

Ten years after the trust was created, and on each subsequent ten-year anniversary, a periodic charge, currently 6 per cent, is applied to the portion of the trust assets that is in excess of the prevailing ‘nil rate band’

The value of the available ‘nil rate band’ on each ten-year anniversary may be reduced, for instance, by the initial amount of any new gifts put into the trust within seven years of its creation

There is also an exit charge on any distribution of trust assets between each ten-year anniversary

Discretionary trust
The trustees of a discretionary trust decide how much income or capital, if any, to pay to each of the beneficiaries but none has an automatic right to either. The trust can have a widely defined class of beneficiaries, typically the settlor’s extended family.

Discretionary trusts are a useful way to pass on property while the settlor is still alive and allows the settlor to keep some control over it through the terms of the trust deed.

Discretionary trusts are often used to gift assets to grandchildren, as the flexible nature of these trusts allows the settlor to wait and see how they turn out before making outright gifts.

Discretionary trusts also allow for changes in circumstances, such as divorce, re-marriage and the arrival of children and stepchildren after the establishment of the trust.

When any discretionary trust is wound up, an exit charge is payable of up to 6 per cent of the value of the remaining assets in the trust, subject to the reliefs for business and agricultural property.

Accumulation and maintenance trust
An accumulation and maintenance trust is used to provide money to look after children during the age of minority. Any income that isn’t spent is added to the trust property, all of which later passes to the children.

In England and Wales the beneficiaries become entitled to the trust property when they reach the age of 18. At that point the trust turns into an ‘interest in possession’ trust. The position is different in Scotland, as, once a beneficiary reaches the age of 16, they could require the trustees to hand over the trust property.

Accumulation and maintenance trusts that were already established before March 22, 2006, and where the child is not entitled to access the trust property until an age up to 25, could be liable to an IHT charge of up to 4.2 per cent of the value of the trust assets.

It has not been possible to create accumulation and maintenance trusts trust since March 22, 2006 for IHT purposes. Instead, they are taxed for IHT as discretionary trusts.

Mixed trust
A mixed trust may come about when one beneficiary of an accumulation and maintenance trust reaches 18 and others are still minors. Part of the trust then becomes an interest in possession trust.

Trusts for vulnerable persons
These are special trusts, often discretionary trusts, arranged for a beneficiary who is mentally or physically disabled.  They do not suffer from the IHT rules applicable to standard discretionary trusts and can be used without affecting entitlement to state benefits; however, strict rules apply.

Tax on income from UK trusts
Trusts are taxed as entities in their own right. The beneficiaries pay tax separately on income they receive
from the trust at their usual tax rates, after allowances.

Taxation of property settled on trusts
How a particular type of trust is charged to tax will depend upon the nature of that trust and how it falls within the taxing legislation. For example, a charge to IHT may arise when putting property into some trusts, and on other chargeable occasions – for instance, when further property is added to the trust, on distributions of capital from the trust or on the ten-yearly anniversary of the trust.

Trusts are very complicated, and you may have to pay IHT and/or Capital Gains Tax when putting property into the trust. If you want to create a trust you should seek professional advice.

How the new rule changes could affect your future planning.

As life expectancy rates in the UK continue to rise, the coalition Government estimates that nearly one in five people will live to see their 100th birthday. Radical legislation will attempt to ensure pension savings are sufficient for these retirees, which in turn will help reduce the burden on the state.

People are also increasingly taking a more flexible approach to retirement, often winding down rather than retiring on a specific fixed date. The new rules allow for that flexibility, enabling you to secure income from part of your pension while keeping the rest invested, for instance. If you are under 75 you are likely to be affected. Even people with some years to go until retirement have something to think about.

While the new rules make these retirement options possible, not all pension providers will necessarily offer all the options. Very few providers already have a drawdown option for traditional personal pension plans. Fewer still are expected to offer flexible drawdown. So these rule changes mean that now is an appropriate time to discuss your pension arrangements with us. On the right, we have provided a summary of the retirement rule changes.

New retirement rule changes from 6 April 2011

The maximum pension contribution limit is reduced to £50,000 from £255,000 annually. The balance of a notional £50,000 annual allowance from the previous three tax years can be carried forward, allowing for potential catch up in 2011/12.

The previous types of income-drawing arrangement have been abolished and replaced by the simple term ‘drawdown pension’, of which there are two types – capped and flexible.

To qualify for flexible drawdown, you must have a secure income stream already in payment of £20,000 per year or more.

Under capped drawdown, the maximum annual income is based on a Government Actuary Department (GAD) calculation of 100 per cent of the relevant annuity, instead of the previous 120 per cent.

Your GAD maximum will be reviewed every three years up to age 75 and annually thereafter.

Drawdown is available from age 55 (or earlier for those with a protected pension age) with no upper age restriction.

If you die after starting to draw an income from your pension, any remaining pension fund will be taxed at 55 per cent, regardless of your age.

Until age 75, there will be no tax charge on death for undrawn funds and a lump sum can be paid to your beneficiaries. After age 75, undrawn funds will be taxed at 55 per cent on death, but ring-fenced from the rest of your estate.

Defined benefits will be valued using a flat factor of 16.

The Lifetime Allowance will be reduced from £1.8m to £1.5m from April 2012.

Tax charges are applicable on funds in excess of the Lifetime Allowance.